Strong quarters, flat stocks

This afternoon, as I was wrapping up meetings in New York City and walking toward Grand Central to catch my train home, I was listening to CNBC and thinking about the Q3 results the major U.S. banks reported earlier this week.

I had already spent time reviewing their earnings releases and filings for the TPC Markets section, so the numbers were fresh in my mind.

Goldman Sachs reported $18.68 billion in net revenue, up 23% from a year earlier and its second-highest quarter ever, with earnings of $17.01 per share against $12.25 a year ago. Citigroup reported its best third-quarter revenue in a decade. Morgan Stanley generated $20.3 billion in net revenue, including a record $9.1 billion in wealth management. JPMorgan earned another $15.3 billion, up from $14.4 billion a year earlier.

Several of these institutions have delivered strong results for consecutive quarters. By almost any historical comparison, their profitability is impressive.

Their stock prices haven't necessarily followed. Heading into earnings season, the KBW Bank Index was down roughly 13% from its August levels.

That reminded me of Samsung last week. The company guided to about 107.4 trillion won, roughly $80 billion, in quarterly operating profit, almost nine times the 12.17 trillion won it earned a year earlier, driven by demand for memory chips supporting AI infrastructure. Its shares fell 2.4% after the announcement.

Samsung's results did fall short of extraordinarily high market expectations, and not all the banks beat analysts' forecasts. JPMorgan's $5.57 per share came in below the roughly $5.85 consensus. But that is beyond the point, so.I would like to go to valuations, and to the possibility of P/E multiple compression.

What investors are paying for

Investors aren't buying last quarter's earnings. They're paying for what they expect companies to earn over the coming years. When those expectations change, they may be willing to pay considerably less for future profits, even while current earnings grow.

The arithmetic is simple. Before its report, Goldman traded at about 13.6 times forward earnings. If earnings grow 10% and investors lower that multiple to about 12.4 times, the stock goes nowhere. Strong results and a flat share price can coexist without anyone being wrong about the numbers. The disagreement is about what those numbers are worth.

The macroeconomic environment makes that especially relevant. September inflation reached 3.7%, with gasoline averaging $4.33 a gallon, a record for the month. The economy added just 29,000 jobs against expectations of around 85,000, and July and August were revised down by a combined 60,000. The Federal Reserve raised rates by a quarter point in September, Treasury yields are weighing on valuations, and the direction of monetary policy is still uncertain.

For banks, the picture is mixed. Higher rates support net interest income, and JPMorgan raised its full-year forecast to about $105.5 billion over the summer. But they also raise funding costs and put pressure on borrowers. In environments like this one, investors watch provisions and credit costs closely, because that is usually where the cycle shows up first.

Some of these same conditions are contributing to today's profits. The AI investment boom has been enormously beneficial for Samsung, while financing, trading and capital markets activity have lifted earnings at several major banks. Goldman's Global Banking & Markets revenue rose 32%, yet its investment banking backlog declined during the quarter. Markets have historically paid less for that kind of revenue, because it depends on conditions that don't last forever. Investors are reasonably asking whether these conditions can keep supporting these results.

A view from payments

From my own experience in payments and credit, I see another consideration. Consumer spending remains resilient, but growing transaction volumes in dollar terms don't necessarily mean households are financially stronger. Higher prices can increase spending figures without a corresponding increase in actual consumption, and they can lift bank fee revenue the same way. Average wages rose 3.0% over the past year while prices rose 3.7%. In real terms, the typical paycheck buys a little less than it did a year ago.

Eventually, that distinction matters for credit balances, repayment capacity and portfolio profitability. When households spend more just to buy the same things, part of the gap often ends up on credit. So far, credit is holding. JPMorgan lowered its full-year card net charge-off guidance to about 3.2% in July, while citing higher revolving card balances as a source of net interest income growth. Revolving balances can grow for reasons that have nothing to do with confidence, and that kind of growth looks very different a year or two later.

More questions than answers

So perhaps the market's reaction is less irrational than it first appears. These companies have extraordinary earnings power, and a few days of weak stock performance don't tell us much about the direction of the economy. But I suspect investors have started assigning lower multiples because they expect that earnings growth will be harder to sustain. If that is the case, the coming quarters will be judged less on what these companies earn and more on how confident investors feel that they can keep earning it.

I arrived at Grand Central with more questions than answers. Are investors seeing something the earnings reports don't show yet, or have they simply become harder to impress?